Who should pay for the money lost by UK and Dutch citizens investing in Icesave accounts? This column presents the dispute's background and argues that the debt burden of Icesave is likely to be closer to 15% of GDP than the 50% often reported. It concludes that Iceland is not too small to repay.

Icesave accounts were internet savings accounts offered by British and Dutch branches of the Icelandic bank Landsbanki, available in the United Kingdom from Oct 2006 and in the Netherlands from May 2008. In the United Kingdom, households, charities, local authorities and even the UK Audit Commission rushed to avail themselves of the seemingly attractive interest rates Landsbanki offered, depositing about £6 billion. More alert investors might have noticed that by the spring of 2008, credit default swap rates on Icelandic banks were among the highest in the world. With no credible foreign currency lender of last resort, it was no surprise when Landsbanki’s UK depositors staged a run on 3 Oct 2008. Landsbanki met its formal demise on 7 Oct, followed within days by Iceland’s two other large banks. The Icelandic government announced that all domestic deposits in Landsbanki would be fully covered; elsewhere the banks’ depositors were in limbo. Apparently uncertain of the Icelandic intent to pay, on 8 Oct 2008 the UK chancellor of the exchequer Alistair Darling employed the Anti-terrorism, Crime and Security Act of 2001 to freeze Landsbanki’s UK assets and then guaranteed that UK retail depositors in Icesave would be repaid in full.1Desperate to receive financial assistance from other Nordic countries and the IMF, on 30 Dec 2008, the Icelandic Parliament narrowly passed a bill agreeing to repay the British and Dutch governments for covering the first 20,778 euros of each retail deposit.2 What was supposed to be the final legislation passed parliament on 30 Dec 2009, but on 5 Jan 2010 the Icelandic President refused to sign it, putting it to a national referendum. The Icelandic prime minister affirms Iceland’s commitment to repay.

In Iceland there is significant anger toward the deal: it is argued that EEA legislation on deposit insurance was never intended to cover the case of the collapse of an entire banking system. Outside of Iceland there has been dismay over Iceland’s asymmetric treatment of depositors inside and outside of Iceland. It is claimed that this disparate treatment violates EEA law prohibiting discrimination on the basis of nationality. More recently, commentators in the United Kingdom have expressed sympathy towards Iceland’s plight and consternation at the lack of British generosity. A recent column by Martin Wolf, for example, bewails the United Kingdom’s treatment of Iceland, claiming that the total UK and Dutch claims on Iceland of €3.9 billion amount to 50% of Icelandic GDP (Wolf 2010). He calls Iceland a “battered and vulnerable little country” and refers to the British and Dutch behaviour as “self-righteous bullying”.

Was the Icelandic government obligated to pay the first 20,778 euros?

Some Icelanders have questioned whether they should be liable for Landsbanki’s obligations. As a member of the European Economic Area (EEA), Iceland is bound by Annex IX (point 19a) of the EEA Agreement, which includes Directive 94/19/EC of the European Parliament and of the Council of 30 May 1994. Directives, by their nature, specify a result that member states must achieve, leaving the form and method up to the national authorities. This directive requires that members are to have and monitor a deposit-guarantee scheme (article 3.1) satisfying certain properties. Two properties are especially relevant for the Icesave dispute. First, under EEA law, a branch of a credit institution is supervised by the authorities of the country where the head office is located. Thus, depositors at a branch are to be covered by the deposit scheme of the head office’s member country (article 4.1). Second, the minimum amount of protection that is to be offered is 20,000 euros (article 7.1).3

In practice, most countries appear to have interpreted the mandate as having and overseeing a fund, paid for in varying part by resident credit institutions and the government, which could be used in the event of the failure of a small to medium-sized credit institution. In Iceland, the Depositors' and Investors' Guarantee Fund (Tryggingarsjóður) is to have funds equal to 1.0% of insured deposits. If this limited interpretation is correct, it is unclear who is liable if an entire banking system collapses and the fund in inadequate.

The directive is not particularly well written, even relative to other EU legal documents. It does not ask member states themselves to guarantee deposits, only to set up and monitor a deposit-guarantee scheme. Indeed, article 3.1 specifically rules out using a sovereign guarantee to satisfy the directive. Article 3.1 requires that “the system must be designed to prevent deposits with credit institutions belonging to the system from becoming unavailable and have the resources necessary for that purpose at its disposal.” However, there is an explanatory introduction (recital) that says that the directive cannot result in the sovereign being liable “if they have ensured that one or more schemes guaranteeing deposits or credit institutions themselves and ensuring the compensation or protection of depositors … have been introduced and officially recognized (paragraph 24).” This is contradictory: if a sufficiently large bank failed, or if an entire national banking system collapsed, only the sovereign might have sufficient resources to guarantee deposits; only a sovereign guarantee is credible.

Most or all of the EEA countries, fearing a run if the guarantee were questioned, interpret the Directive to mean that the first 20,000 euros must be paid. The question, however, is who should pay? Despite the legal uncertainties, Iceland has expressed a willingness to repay if the terms are reasonable. Exactly what constitutes reasonable terms, however, is open to question.

Did Iceland unfairly discriminate on the basis of nationality?

After the collapse of Landsbanki, the bank was split into two separate entities: (old) Landsbanki and Nýi Landsbanki. All deposits located in Iceland were moved to Nýi Landsbanki and are fully guaranteed by the Icelandic government. The British and Dutch have argued that only guaranteeing deposits situated in Iceland constitutes a breach of Article 4 of the EEA Agreement.4

Article 4 of the EEA Agreement, which is the analogue of Article 12 of the consolidated version of the Treaty on the Functioning of the European Union, prohibits "any discrimination on grounds of nationality". However, past court cases make it clear that the force of this is limited. In the 2007 case of James Wood v. Fonds de garantie des victimes des actes de terrorisme et d'autres infractions (case C-164/07) it is stated that, "It is in this regard settled case-law that the principle of non-discrimination requires that comparable situations must not be treated differently and that different situations must not be treated in the same way. Such treatment may be justified only if it is based on objective considerations independent of the nationality of the persons concerned and is proportionate to the objective being legitimately pursued (paragraph 13)”.5 In a past case that is frequently cited on this matter, the court explicitly considered both the importance and quality of the objective being pursued and whether the discrimination was proportionate.6 In this light, compensating domestic, but not foreign, account holders in full, regardless of their nationality, on the grounds that it is residents who pay the taxes to finance this and that such a move was necessary to maintain a functioning banking system does not seem obviously indefensible.

Is Iceland too small to have to repay Icesave?

Martin Wolf is only one of several British journalists who have recently claimed that Iceland is too small to have to shoulder the burden of Icesave. While the debt is substantial, claims that it amounts to 50% of GDP seem disingenuous. The obligation to repay is borne first by the Icelandic deposit insurance fund. If the Icesave agreement is finalised, this fund, along with the funds operated by the United Kingdom and the Netherlands, will have a priority claim on the assets recovered from Landsbanki; the Icelandic fund will receive about half. The government is liable for the rest of the claim, with repayment (including interest accrued from the start of 2009 at a rather unfavourable rate of 5.55%) beginning after seven years. Recent estimates are that close to 90% of Landsbanki’s assets will be recovered. In this case, the estimated net present value of the end of 2015 Icesave debt burden is only about 14% of Icelandic GDP. This amounts to a net present value is 3,600 euros per capita and the average payment burden is less than 1% of GDP per year from 2016 until the debt is fully paid in 2024. If the asset recovery rate turns out to be only 75% then the average payment burden would be 1.2 of GDP from 2016 to 2026. While this burden is just part of the cost of the crisis for Iceland’s taxpayers, who have already experienced an unprecedented fall in their real disposable income, it should not be crippling. While Iceland’s position in regard to the law may have merit, and while Gordon Brown’s government can indeed be described as bullying and lacking generosity, Iceland is not too small to repay.

Footnotes

1 The Gordon Brown’s government is playing Robin Hood in reverse: transfer money from tax payers to those who have more than £50,000 to speculate in risky foreign investments.

2 Landsbanki was a member of the UK’s Financial Services Compensation Scheme which was liable for the difference between 20,778 euros and £50,000.

3 The Icelandic scheme offers 20,778 euros.

4 In addition, the Icelandic guarantee fund covers certain wholesale deposits not covered by the UK fund or by the Icesave agreement.

5 In this case, the court decided in favour of a British national residing in France who claimed he was treated differently from other French residents in a particular matter because of his nationality.